LLC Operating Agreement Help Guide

Besides being required in some states, there are many reasons why LLC operating agreements are a vital tool for any limited liability company regardless of its state of incorporation. Most importantly, an LLC operating agreement helps you avoid internal conflict by providing a roadmap that defines the company's structure and ground rules. This is essential for avoiding the types of misunderstandings that often prevent young companies from getting up on their feet. The provisions in your LLC operating agreement should leave no room for ambiguity.

The LLC Liability Shield

LLC operating agreements are becoming the go-to device for helping shield company members from personal liability (or individual liability for members that are business entities). This is accomplished by clauses throughout the agreement that work to distinguish the LLC from the partnership or sole proprietor business forms. These forms are directly tied to the ownership so as to require personal liability for most obligations of the business. Furthermore, the exculpation (defense) and indemnification (repayment) clauses in LegalNature's LLC operating agreement work to ensure that any members or managers will be defended by the LLC under most scenarios where they could be attached personally.

The state default rules will apply to all LLCs without operating agreements or where such operating agreements do not touch on a particular rule discussed under the state LLC Act. This makes it all the more important to have a thorough and clearly drafted agreement. State default rules are not tailored to the specific circumstances of your business and can therefore be very detrimental at times. LLC operating agreements enable you to avoid many potentially default rules that could hurt your company later on.

The following information will help you create a well-written LLC operating agreement using LegalNature's intuitive and easy form builder that clearly establishes the relationships among all the members, each member's and manager's (if any) responsibilities to the LLC, as well as set up the ground rules for how important decisions concerning the LLC will be made. It will include managerial responsibilities, provisions for abiding by state and federal business and tax laws, voting rights and procedures, meeting guidelines, how profits and losses will be divided, and more.

Member Information

After entering in the background information about the company, you will need to enter each member's name, capital contribution, and ownership percentage. Describe all types of capital contributed, which could be any type of asset, such as cash, real estate, intellectual property, or personal property. You should also include the value of each asset as well as the total value of all capital contributed by each member.

Each member's ownership percentage represents the percentage of the LLC it owns and will be a factor in determining its voting power and distribution rights, as well as its allocation of profits and losses. The ownership percentages should all add up to 100%; so, for instance, if there are three members splitting ownership equally, then you would enter 33.33% for each.

Management

You will also need to indicate whether you want the LLC to be managed by its members or whether you want to appoint managers to handle the day-to-day responsibilities. There are pros and cons to each option, and the decision comes down to your company's unique circumstances. There are many online guides that discuss the various considerations in more detail. However, one of the main considerations is whether the members prefer to remain passive investors with no managerial responsibility, or whether the members will be directly involved in running the company operations.

Remember that a manager may also be a member, and there may be multiple managers. Often, what occurs for LLCs is that one member will also be appointed as the manager and will therefore contribute less initial capital since it will be contributing to the LLC by managing its operations. A manager's ownership interest in this situation is often referred to as "sweat equity" because the manager's interest comes from its work for the LLC instead of purely from contributing capital.

Voting

Deciding how votes will be passed is another important issue for the members to determine in the LLC operating agreement. Your agreement will automatically require unanimous consent of all members on issues that are extremely important to the survival of the LLC and to each member's ownership interest. However, you will need to decide whether other issues will require an affirmative vote by members holding a majority of all company ownership interests in order to pass, or whether a simple majority of the total number of members will be required (one member, one vote).

The first option is a higher threshold to meet and is therefore a more conservative way to pass decisions. You should also consider whether the voting structure you choose will allow for the possibility of a tied vote. This can happen, for instance, if you choose the second option and there are an even number of members. In that scenario, half the members could vote for a proposition and half could vote against it, resulting in a deadlock.

Deadlocks can be frustrating for a company to deal with; however, some LLCs choose to allow these to occur, having the mindset that a proposition should not pass unless a true majority exists (for example with three out of four members voting to pass it). One way to avoid deadlocks would be to choose the second option and have an odd number of members or choose the first option and make sure that the ownership percentages cannot be divided in such a way as to be 50%–50%.

Tax Treatment

With this question, you should indicate any tax treatment already selected on the articles of organization (called the certificate of formation in some states). If you did not select a tax treatment on that document, then you should indicate how you plan for the LLC to be taxed.

The standard tax treatment is for the LLC to be taxed as a pass-through entity, meaning the members will only be taxed once on the income they receive. This same tax treatment will be applied if you select "S corp tax treatment," which is the tax treatment for small, closely-held corporations that meet certain requirements of the IRC.

If you select "C corp tax treatment," then you will be taxed twice, as would a normal corporation, at both the entity and personal levels. However, there may be instances when this treatment is desirable and can result in overall savings to the members. Again, there are numerous online guides that go into more detail about this decision-making process. You should consult a tax attorney or financial advisor if you have any doubts.

Final Steps

To execute the document, all members and any managers will need to sign the attached signature pages. Each member and manager (if any) should fully review the document and consult with their own independent attorneys or financial advisors if necessary. Each signing party should have its signature witnessed by a notary public to help ensure the validity of the document will never be questioned. Distribute copies of the final executed document to all parties, including all signature pages.